What actually is a recession?
5th October 2022
If you pick up a newspaper or catch the news on TV, you can’t miss the ‘are we going into a recession?’ headlines. There have been a number of changes in the economy recently caused by the effects of the pandemic, the removal of the energy cap, Brexit and war in the Ukraine, which have fuelled a steep rise in the rate of inflation and the cost of living. Financial pundits are now talking about the UK economy going into recession before the end of the year, as the accumulative effects of these changes start to bite. But what is a recession, and how will it affect your business?
What is a recession?
The technical definition of a recession is two successive quarters (or six months) of decline in the UK economy (GDP). GDP is the value of goods and services measured in pounds sterling, but its growth, or lack of, is normally shown as a percentage. It is when the economy starts to slow down, and this percentage is a negative figure that is defined as a recession. The UK economy last saw a recession in 2020 during the lockdown when GDP fell by 20% from April to June – an unprecedented drop.
The Bank of England has predicted a 13% inflation rate and a decline of 1% in GDP by the end of this year, which will continue to fall throughout 2023. The UK’s leading macroeconomic, social research and forecasting institute, NIESR has predicted that interest rates will rise to 2% by the end of this year and 2.5% in 2023 to try to halt the rise in the rate of inflation.
At the moment, the UK is in a tricky financial position. Normally when a recession is predicted, interest rates fall, and tax rates may be cut to stimulate the economy. But when inflation is high and continuing to rise rapidly, there is an argument for raising interest rates (which we have just seen), and taxes to fight this problem. Read more about a recession and its causes in Forbes Advisor.
What is a recession and how does it affect my business?
A recession can impact businesses differently, depending on the industry and business type (e.g. retail, manufacturing or service.) However, there are key issues that will affect all businesses.
Sales levels
Consumers tighten their belts and cut back on spending, so sales levels will fall, especially for non-essential goods and services. As sales fall, profits will too, so businesses have less to invest in new machinery and resources.
Cost cutting
The impact of falling sales can result in cost cutting including moving to smaller premises or premises in cheaper areas. Manufacturers may have to turn off machinery, close down plants and source cheaper components.
Declining standards
The high standards normally applied to products or services may fall if businesses are forced to cut costs i.e., sourcing cheaper components or letting skilled staff go, which could affect a company’s reputation and profits longer term.
Making payments
When cash flow is reduced, it is more difficult to make payments on time. It is increasingly important that customers pay invoices on time and in full and those who go out of business do not owe money for goods or services.
Obtaining credit
Consumers are not the only ones who cut down on spending, lenders do too. Therefore it could become more difficult to obtain credit, with more stringent terms.
Stock Market
If your business has shareholders, their dividends will decline as profits fall. If the share price is affected, it could have an impact on your company’s financial statement and the Board of directors.
What is a recession and how can my business survive?
In order to survive a recession, you need to be prepared. Your business will need financial resilience to withstand the effects, or even flourish whilst others are floundering. It is very therefore crucial that you understand financial reports/information and are in control of your company’s finances.
Financial planning
In order to have the financial resilience to cope with difficult trading conditions, you need to manage the cash flow of your business. A cash flow analysis can provide a lot of information:
- Identify trends – products where sales are increasing/decreasing
- Late payers – who to incentivise/chase to pay on time
- Inefficiencies – where you could cut costs
- Potential – where you can reallocate costs
The knowledge gained by financial planning can help you to diversify/pivot when regular sales are falling. This will enable you to react quickly to an economic slowdown, reallocating resources to new income streams that may help your business to succeed when normal trading conditions are challenging. You should build a reserve fund to make sure your company can ride out any difficulties. For more on building financial confidence, read our recent blog on financial resilience.
At Mellor Financial Training, we specialise in finance for non-financial managers and owners of small businesses. So, if you don’t understand financial jargon, or just can’t get to grips with the numbers, gain financial confidence by attending one of our training courses.
Business planning
Alongside a financial plan, every business should have a business plan, detailing your business strategy and the milestones from the present to where your business will be in the future. You need this clear understanding of your business in order to react quickly to changes in the trading or economic environment:
- What it does and why
- The market it operates in
- Its strengths and weaknesses
- Your competitors
- Your customers
- Identify new opportunities
Having in-depth knowledge of your business – how it makes money and how you will reach your goals – is fundamental to business planning. A strong business plan will include contingency planning, so that you can identify new opportunities, capitalise on your strengths and be prepared for obstacles or difficult trading circumstances.
Business planning will enable you to understand your customers and the need your product or service fulfils, so you can decide how to communicate when sales start to decline. Identifying how to meet their needs and capitalising on customer communications could give you the competitive edge. If you don’t have a business plan, or need a guide to what it should contain, the Federation of Small Businesses has a guide on what to include.
What is a recession – is there any good news?
We hope this blog has answered the question ‘what is a recession’, outlined its effects and shown you the essentials for survival. It is important to remember that good financial planning and business planning can provide you with the knowledge you need to succeed where others may struggle. You could identify a:
- Better business model
- More cost-effective process
- Innovative ways of meeting customer need
- Way to diversify/pivot
- New markets for your product/service
If you feel there is a financial skills gap in your business, Mellor Financial Training courses cut through the jargon to give you financial confidence. Why not talk to us today to see how we can help you to understand the basics of financial planning? Our finance for non-financial managers courses will give you the understanding and confidence to make crucial decisions in preparation for a recession, to build business resilience and hopefully survive an economic storm.
